Actual fraud is more challenging to prove than constructive fraud. Debtors are unlikely to admit they transferred assets without reasonably equivalent value consideration for the purpose of defrauding their creditors, and documentary evidence of intent is also unlikely to exist. Thus, courts must evaluate the debtor’s actions and use factors termed the ‘badges of fraud’ to determine if intent to defraud can be inferred from those actions.
Here are a few questions the courts may consider:
– Is there a close relationship between the parties to the allegedly fraudulent transaction?
For example, a debtor husband transferring property to his wife, or a debtor company transferring money to an affiliated company, outside the usual course of business, can be construed as intent to defraud.
– Was the transaction within the normal course of business?
If a company transferred all its computer equipment and furniture to an affiliated company, a court may find this to be outside the normal course of business and may infer intent to defraud the creditor.
– Did the debtor have knowledge of the creditor’s claim and its inability to pay?
When a debtor receives communications from a creditor regarding the debt, but proceeds with transfers leaving insufficient assets to resolve the debt, the courts may find that indicative of intent.
– Does the debtor retain any control of the property?
If the debtor still controls the transferred assets, a court may infer intent. This can be seen where a debtor transferred property into an LLC of which he is the managing member, or a company transferred property to an affiliated company; while it is no longer the debtor’s property it remains within the debtor’s influence.
What are the benefits to filing a claim for actual fraud, since it is so difficult to prove?
First, a claim for actual fraud may be brought within two years of when the actual fraud should have been discovered, which may be outside of the six-year statute of limitations for constructive fraud.
The other significant advantage is that under 276-A of the Debtor and Creditor Law (DCL), if actual fraud is proven, the creditor will be entitled to additional damages of attorney’s fees. If the fraud case is strong, this threat may force the debtor to seek a less costly resolution.
Since a claim for actual fraud can be filed in the same lawsuit as a claim for constructive fraud, there is no reason not to pursue both if the evidence fits the standards discussed above.
In our next article, we will discuss burdens of proof in fraud cases.
NOTE: This article has been updated to reflect the Uniform Voidable Transaction Act, an amendment to the DCL, which went into effect April 3, 2020.
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